How Will the Rate Cuts Impact Credit Unions?

After holding the Federal Funds rate at 5.25 percent for more than a year, the Federal Reserve has now lowered the target rate by one percent in less than two months. Will the reduction in rates be a positive for credit unions?


After holding the Federal Funds rate at 5.25 percent for more than a year, the Federal Reserve has now lowered the target rate by one percent in less than two months. Credit issues have reduced liquidity in the market and this past week the Fed not only announced another rate reduction but also launched a coordinated effort with other central banks in an attempt to keep the lending markets active.

Credit unions maintain ample liquidity with a loan-to-share ratio of 82.6 percent, but the rate cuts still have an impact on the industry due to its interest rate sensitive balance sheet. The net interest margin has stabilized in 2007 but changes to loan and deposit pricing will be felt in the margin in coming quarters. The components of the balance sheet most immediately impacted by the cuts, however, will be the investment and borrowing portfolios.

Investment and Borrowing Maturities Extended
Investment maturities have been extended slightly in the $197 billion credit union investment portfolio during 2007, which should benefit credit unions. Investments that mature in more than three years comprise 14.9 percent of the portfolio as of September versus 12.1 percent at the end of 2006. Credit unions have shifted out of the one-to-three year maturity range during the year to accomplish this, with that segment of the portfolio moving from 29.1 percent to 26.3 percent of the total.

The majority of the investment portfolio continues to be shorter-term in nature. With greater uncertainty about the direction of rates at the beginning of the year, credit unions held 58.8 percent of the portfolio in investments that mature in less than one year in December 2006. That proportion increased in the first quarter to 62.8 percent as share balances rose at the fastest rate in four years. Since the end of the first quarter though, investments less than one year in maturity have fallen to 58.7 percent. Given the maturity mix, credit unions will see a decline in the investment portfolio yield but the impact of the cuts will be lessened somewhat due to the extension of maturities during the year.

Credit union borrowings have increased by $2.7 billion during the year to reach $23.7 billion as of the end of the third quarter. Borrowing maturities have also slightly extended during the year, with the less-than-one-year segment declining from 42.9 percent at year-end 2006 to 38.3 percent as of September. A higher proportion has been directed to the one-to-three year maturity bucket, which has risen from 23.4 percent to 27.4 percent over the nine month period.

A Net Positive
Overall, credit unions are likely to see more pressure on the margin from the investment and borrowing portfolios due to the maturity structure of these two components. Given their relative proportion to the $761 billion industry balance sheet though, shares and loans will continue to be the primary drivers of net interest margin. Core deposits, priced on short-term rates, represent 58 percent of the share portfolio as of September. Although the rate cuts will likely spur some loan refinancing activity, shares are still likely to reprice faster than loans. Thus the net impact of the rate cuts should be a positive for the industry.




Dec. 17, 2007


  • For most credit unions core deposits will not reprice faster than loans if short terms rates fall in 2008. Most CU''s raised core deposit rates minimally during the rising rate environment starting in 2004. This means rates won''t have the ability to be lowered if rates drop. If 58% of the portfolio is core deposits and the other 42% consists of long term funding (1 year or more CD''s) CUs may not be able to reprice shares. Core deposits always show short durations and exaggerate NEV in a rising interest rate environment. This also exposes, and exaggerates NEV if rates fall and you can''t reprice funds.